Why No Portfolio Is Truly Passive: The Active Decisions Behind Passive Investing
Why Every Investment Strategy Involves Active Decisions
The debate around active vs passive investing is one that continues to split opinion. This is the third time I’ve found myself writing about it — and it still stirs up plenty of strong views.
Not long ago, another adviser asked me, “Are you still passive?”
My reply: “It’s not passive — it’s a low-cost, rules-based active strategy.”
That might sound like splitting hairs, but in our view, there’s no such thing as truly passive investing — at least not when you’re managing a portfolio. Even if you use only passive funds, the portfolio as a whole is still being actively managed.
Why? Because you still have to make important decisions — which countries to invest in, how much to allocate to each region or sector, whether to tilt towards certain types of companies, how often to rebalance, and whether or not to hedge currency exposure. These are all active choices. And over time, they have a material impact on investment outcomes.
When investing, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invested, particularly where investing for a short timeframe. Neither simulated nor actual past performance is a reliable indicator of future performance.
A Fund Can Be Passive…
An individual fund can absolutely be passive - it either tracks an underlying index or it doesn’t.
Active investing is about trying to beat the market — stock picking, timing transactions, and making tactical calls.
Passive investing, by contrast, means tracking a market index as closely and cheaply as possible — with no attempt to outsmart it.
The rise of index funds and ETFs (exchange-traded funds) has made passive investing more popular than ever — and for good reason. The evidence shows most active funds underperform after costs. According to Morningstar’s Active/Passive Barometer, just 29% of actively managed US mutual funds beat their average passive peer over the 10 years to June 2024 - click here for an article on this).
…But a Portfolio Can’t
(in our view)
Even if your portfolio is made up entirely of index funds, building and managing that portfolio still involves multiple active decisions. Here are just a few of the key levers:
1. Choice of Index
Let’s say you’ve decided to take a more ‘passive approach’ — i.e. you want to track an index. But which index do you track?
If you want exposure to US stocks, do you follow the S&P 500 (the 500 largest US companies)? Or the Nasdaq, which is much more tech-focused? Or the older-school Dow Jones, which tracks just 30 major US companies?
In the UK, do you go for the FTSE 100 (the biggest UK-listed firms), the FTSE 250 (which adds more mid-sized companies), or the FTSE All-Share, which gives broader coverage?
Now say you want a globally diversified portfolio — as all our clients do — and you’re looking for international exposure. Most people default to the MSCI World Index, which is probably the most widely quoted global benchmark. But even here, there’s no single version:
MSCI World: Covers only large- and mid-cap companies in developed markets.
MSCI World IMI: Adds smaller companies.
MSCI ACWI: Expands to include emerging markets like India and Brazil.
MSCI ACWI IMI: The broadest version — includes large, mid, and small companies from both developed and emerging markets.
All of these are “passive” indices. But the one you choose — and the exposure it gives you — can make a significant difference to your portfolio’s behaviour over time.
For example, as of 5th September, the MSCI World Index has delivered an annualised return of +12.6% over the past ten years, compared to +11.8% for the broader MSCI ACWI IMI. That 0.8% gap might not seem huge, but over a decade, it compounds into a 23% difference in total returns.
The main reason is that the MSCI World has a roughly 9% higher weighting to US stocks — around 72% vs 63% for the more diversified ACWI IMI. Given the dominance of US tech over the past decade, that extra exposure has boosted returns — but it also means more concentration risk, which may not always work in your favour going forward.
2. Market-Cap vs Equal-Weight
Two funds can track the same market — like the S&P 500 — but in different ways:
Market-cap weighted funds give more weight to larger companies (e.g. Apple, Microsoft).
Equal-weighted funds give each company the same slice, regardless of size.
Both are technically passive. But choosing between them is an active decision — with meaningful implications for risk and return.
3. Factor Exposure
Many investors choose to tilt towards specific types of companies (or “factors”) that have historically outperformed:
Value: Cheaper stocks based on fundamentals.
Small-cap: Smaller, more agile companies.
Profitability: Companies with strong, consistent earnings.
These tilts can be delivered using passive funds. For example, a tracker that follows the FTSE 250 naturally gives you some small-cap exposure.
But the decision to emphasise these factors — by overweighting those funds in your portfolio — is still active. These strategies also bring higher volatility and can underperform for years at a time, requiring conviction and patience to stick with them.
4. Rebalancing Framework
Over time, some parts of your portfolio will grow faster than others. Rebalancing helps bring things back in line.
But how you rebalance is another active choice:
Calendar-based (e.g. quarterly or annually) is simple, but can lead to unnecessary trades, adding cost and potentially forcing you to sell strong performers too early.
Tolerance-based (e.g. only rebalance if an allocation drifts more than 5%) is often more cost-efficient and allows you to let winners run a little longer.
Either way, you're making decisions — and those decisions matter.
5. Currency Hedging
This is one of the most overlooked (but important) decisions.
Unhedged portfolios leave foreign exchange risk intact.
Hedged portfolios smooth out currency moves but add cost and complexity.
Consider this: from January to June 2025, the S&P 500 returned +3.6% in USD. But UK investors holding it unhedged actually saw a negative -4.8% return due to a stronger pound. That’s an 8% swing, purely from currency movement.
The Bottom Line
So when someone asks if we're "still passive," the honest answer is no.
Whilst our approach harnesses the cost and efficiency benefits of passive investment vehicles (low cost, high diversification), it operates within what's fundamentally an active framework. Every geographic allocation, every factor tilt, every rebalancing rule, every currency decision represents an active choice that shapes your portfolio's risk and return characteristics.
This isn't investment industry jargon or unnecessary complexity—it's the reality of thoughtful portfolio construction. Recognising these decisions for what they are allows you to make them more deliberately and effectively.
Happy Thursday!
Kind regards,
George
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Important Disclaimer
This blog is for general information only and is intended for retail clients. It does not constitute financial or tax advice, nor is it an offer to buy or sell any specific investment. Since I don’t know your personal financial situation, you should not rely on this content as tailored advice. While we aim to provide accurate and up-to-date information, we cannot guarantee that all details remain correct over time. We are not responsible for any losses resulting from actions taken based on this blog’s content.
